Stress tests important for banking supervision

Release date

06 July 2018

What would happen to the banking system if a downturn in the Chinese economy caused a fall in New Zealand exports, rising unemployment, falling house prices, and three years of low payment to dairy farmers?

That’s one of the scenarios that the Reserve Bank posed to the country’s four largest banks in stress tests last year.

The Reserve Bank today published an overview of how stress tests are used to monitor the stability of the financial system, along with detailed results from the latest exercise.

Deputy Governor Geoff Bascand said: “A stress test models the effect of a severe but plausible scenario – such as a major economic downturn – on the balance sheet of a financial institution. Since the Global Financial Crisis, stress tests have become a widely used tool by banking supervisors in most countries.”

As part of their role in monitoring financial stability, stress tests are adapted over time to investigate new or emerging risks. The latest test includes a previously unexplored scenario, where losses related to mortgage misconduct coincide with a macroeconomic downturn.

The Reserve Bank expects banks to be well capitalised, so they can continue providing credit to the economy even under severe stress scenarios. Consistent with past exercises, the major banks in New Zealand can absorb significant losses while remaining solvent under the various scenarios tested.

Stress test results are also an input to the calibration of capital requirements, which are currently under review. There is no automatic link between the two, reflecting uncertainty around how stress scenarios would play out in reality, and that the nature and duration of the stress is never known in advance.

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